One of the most important factors one needs to consider when planning for your retirement is to ensure that your pension lasts throughout your retirement – the risk of it not doing so is known as Longevity Risk, and is certainly something that your adviser should discuss with you if you choose to seek advice. Making your pension last as long as you do is easier said than done – predicting the state of your health up to 25 years in the future is almost impossible – as indeed is trying to predict the inevitable improvements in healthcare that will occur in the next quarter of a century. The Government likes to think that it has made this prediction process slightly easier for us all by publishing life expectancy projections. These are based on historical data as well as recent trends in the increase in life expectancy, and are the best we can get at the moment. Statistically, they can tell you the very day on which you will die, if you are the average person born on your birth date. But as we all know, none of us are average.
Well, the first thing to do is to get to grips with what ‘average ‘ life expectancy actually means. The chart below shows the most recent life expectancy projections for people who are now aged 60, 70 and 80. In the absence of any other guidance it makes sense to make sure that your pension will last as long as, and preferably a lttle longer than your life expectancy. We have a variety of pension calculators to help with this; our ‘Dead Parrot’ Calculator allows you to enter your birth date and the size of your pension pot – the Calculator will then tell you how much you can afford to withdraw in income each month if you want that income to last as long as you do. The UFPLS Pension Drawdown Calculator comes at the problem from the other direction in that it allows you to input a desired monthly income from your pot using the Uncrystallised Fund Pension Lump Sum scheme – the Calculator will then tell you the age at which your Pension pot will have shrunk to a zero balance.
But this is not the whole story of course, because it is in the nature of what an average is, that as many of us will die before that average age as will live beyond it. The second chart shows the real life bell curve of actual deaths of people who are now aged 65.
Whilst the average 65 year old will live until they are 86, 50% of those now aged 65 will live longer – one in four of them (25%) will live past age 90 and one in 10 will live past 95.
To accommodate this risk of outliving your pension can be expensive, and is one of the reasons why annuities are still relevant to retirement planning. Retrement plannng schemes from pension providers and advisers are increasingly combining a drawdown strategy in the early part of retirement with the purchase of an annuity at a later age, when the cost of securing a reasonable income for life is lower.
Financial Advisers consider that the longevity issue is the single most important aspect to consider when retirement planning. This is where advisers earn their fees because, while the risk of outlasting your pension cannot be completely eliminated, it can be planned for and managed through a variety of techniques, financial products and planning strategies (like the drawdown/annuity option mentioned above).
The management of Longevity Risk is a complex task and one that is certainly worth discussing in detail with an adviser. As we have discussed elsewhere, such advice is no longer cheap – but if it means you are able to enjoy your retirement and know your money will last as long as you do, then you may consider it a good investment.
Do you have any experience of managing longevity risk that you would be happy to share, or have some thoughts on the best way to approach it? All comments and ideas are always welcome.
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